What is a Shareholder’s Agreement and why do you need a Shareholder’s Agreement?

If we can assist with the preparation of a Shareholder’s Agreement or any other company law matter please contact andrew@bradleyhayneslaw.co.uk or call us on 01905 900979.  

What is a Shareholder’s Agreement?

In a limited company, each share carries the right to vote, the right to dividends and the right to return of capital on a sale or winding up.  In most cases all the shares are of ordinary shares and the rights of each share rank equally.

There are many situations where the shareholders wish to vary the rights attaching to each share under the company’s articles of association and that is commonly where a Shareholder’s Agreement is used.

In practice, company law and the standard articles of association for limited companies do not work well for the operation of small limited companies and a Shareholder’s Agreement should be advised from the outset of any shareholder relationship.  The cost at the outset will always seem high especially for a start-up venture, but not having a Shareholder’s Agreement can cause significantly greater costs later in the company’s life cycle.

Why do you need a Shareholder’s Agreement?

Some reasons for having a Shareholder’s Agreement may be as follows:

• To have a more equal distribution of power than the percentage shareholding held.
• To protect smaller shareholders from exploitation.
• Where several people work together and wish to arrange for commercial decisions to be taken unanimously, or by a certain percentage.
• Where shareholders are not directors and therefore are not in any position to control the company’s affairs but wish to have a say in certain “restricted” decisions;
• Where shareholders have formed a company for a specific joint venture and wish to set out the rules as to what each party will contribute;
• Where shareholders wish to have equal rights to vote but vary other rights such as dividend return or return of capital on a sale. This is usually done by reclassifying the ordinary shares as ordinary A and ordinary B shares and then setting out the rules which apply to both in the Shareholders Agreement.

It is also usual for a Shareholder’s Agreement to cover several other matters which are usually not dealt with in any detail in the articles of association of the Company, including:

Intellectual property – Setting out who owns the rights in trademarks, designs, logos, website etc.

Transfer of Shares and Exit – In basic terms any shareholder is free to sell their shares to a third party without reference to other shareholders. This is usually not suitable in small companies where the remaining shareholders may not want to work with that third party.  The Shareholders Agreement will usually set out a process to follow if a shareholder wishes to exit the company, usually offering their shares to the remaining shareholders before any sale can take place.

Worst Case Scenarios – A Shareholder’s Agreement will usually set out what happens if a Shareholder dies, usually allowing the company or the remaining shareholders to acquire the shares, so that a new third party can not be left the shares from the estate of the deceased. This often works hand in hand with life insurances.  Shareholder’s Agreements often also deal with matters such as critical illness.

Employee Shares – Often employees are gifted shares of buy in to the Company.  Often the Shareholder’s Agreement will set out that those shares can be acquired back from the employee if they leave their employment.  Failure to set out such rules before shares are granted to employees can cause business critical issues if there is a dispute.

Sale of the company – Often there are rules in a Shareholder’s Agreement setting out that if a certain percentage of shareholders wish to sell, they can “drag” other shareholders to also sell their shares.  It is often drafted in a Shareholder’s Agreement that minority shareholders can “tag along” with a sale if a majority wish to sell their shares so they are not left behind with the new buyer.

Rules for directors – a Shareholder’s Agreement will usually go into far more detail on the commercial decision-making powers of director than company law and the company’s articles.  For example, the director may have to seek a percentage shareholder approval for buying an asset over a certain value or committing the company to a loan.

Restrictions – a Shareholder’s Agreement will often set out provisions confirming that a director will not compete with the company during their ownership of the shares and for a period thereafter.  This is especially the case if a shareholder is not an employee and has no such clauses in an employment contract.

If we can assist with the preparation of a Shareholder’s Agreement or any other company law matter please contact andrew@bradleyhayneslaw.co.uk or call us on 01905 900979.